Factoid: Percentage of Federal Income Tax Paid by the Top 1%

Mark Perry shares this graph of the percentage of Federal Income Taxes paid by the top 1% and bottom 95% of earners in the US.

This information comes from the Tax Foundation which provides the following histogram of the average tax rate paid by various income groups in the US:

It is interesting to note that the top 1/10 % pays a slightly lower tax rate than the top 1%. This may be due to capital gains (which are taxed at a lower rate than earned income) constituting a larger share of their income.

So, what's the point here? While I don't want to come off as too conservative, I think these graph do undercut the progressive argument that the rich are not paying their fair share, as far as Federal Income Tax goes. Of course, "fair" is a nebulous term (indeed, I sometimes call it the f-word), but when the top 1% are paying more in absolute terms and as a percentage of their income, it's hard to see what is unfair about this to anyone to the average middle-class American. I certainly can't see how one could justify raising taxes on the top 1% (or 5%) based on the current taxes being unfair.

However, this doesn't mean that we should not raise taxes on the top earners. If taxes need to be raised, the key question, to my mind, is where does it make the most fiscal and economic sense to raise them. Fiscally speaking, it used to be conventional wisdom that you had to raise tax rates on large numbers of people to realize significant revenue. But the top graph suggests that this is much less the case now than it was in the 1980s or early 1990s. If the top 1% and bottom 95% are paying about as much in taxes, adjusting the tax rates of either group by a given percentage will produce about as much revenue. Indeed, since then the top 5% are paying 59%, and adjusting their tax rates by any given percentage will produce more revenue than applying the same change to the bottom 95%.

As for the economic impact, the choice between raising tax rates on the rich versus raising them on the middle class is between discouraging investment or discouraging consumption. This is because the rich tend to save and invest more of their income than does the middle class. Given that interest rates and inflation are low, it appears that capital is relatively abundant in comparison to consumer demand, which suggests that raising taxes on the rich is the least bad option.

Furthermore, if you look at the second graph, there is kind of any obvious place to raise taxes since the top 1/10% are paying a lower tax rate than the top 1%. If this is because of the lower capital gains tax, then raising the capital gains tax seems like a logical place to start.

But hey wait! That's exactly what President Obama  suggested doing in his State of the Union speech, albeit based on an entirely different rationale. So while I reject the fairness based reasoning employed in the political rhetoric, I do support the specific policy (which is presumable rafted by less rhetorical economists).

Of course, this all begs the question of whether taxes need to be raised in the first place. The graph of federal expenditures below is why I lean towards saying that they do need to be raised. It shows that, for good or ill, the federal government has kept spending constant for the past few years. This suggests to me that we have gone about as far as we should go with cost cutting and so tax increases of some kind should be on the table. But, hey, that's just me (the blog is called thinking out loud).